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Review of Development Finance 7 (2017) 1–5
Financial sector development in Africa–an overview
It is now generally accepted that financial sector develop-
ment is central to economic development (Levine, 1997), and
that inclusive financial systems are important for inclusive devel-
opment (Levine, 2004, Park and Mercado, 2015). The positive
impact of financial sector development on economic perfor-
mance is also supported by evidence from Africa, although the
results are not strong mainly due to poor quality of available
data (Senbet and Otchere, 2010).
Financial systems perform multiple functions, including
liquidity provision, information production, price discovery, risk
management, and governance, etc. (Levine, 1997). For financial
development to have the desired impact, there has to be clear
channels or linkages to economic development. In the banking
sector, for instance, mere savings mobilization is insufficient
unless these savings are intermediated for efficient resource allo-
cation through private credit provision. By the same token, the
mere existence of stock exchanges is immaterial unless they
are active in the production of information and liquidity through
well-functioning trading systems (see Senbet and Otchere, 2010,
for details). Therefore, in designing financial sector reforms,
policies should be guided by a functional perspective of financial
systems, and not just savings and capital mobilizations.
To enhance the developmental potential of finance, most
African countries liberalized their financial sectors between the
late 1980s and the late 1990s, mostly as part and parcel of the
structural adjustment programmes promoted by the IMF and the
World Bank. The reforms included removal of credit ceilings,
liberalization of interest rates, restructuring and privatization of
state-owned banks, the introduction of a variety of measures
to promote the development of private banking systems and
financial markets. Accompanying these measures were bank
supervisory and regulatory schemes, including the introduction
of deposit insurance in certain countries (Cull et al., 2005).
At a broader level, a more liberalized financial environment
has emerged in Africa because of financial sector reforms. These
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reforms have also been stimulated by rapid improvements in
global conditions and technology connecting Africa with the
outside world. Therefore, it is not accidental that Africa began
to experience good performance both in the real and financial
sectors. Until recently, Africa had experienced uninterrupted
growth for about two decades, and was for many years one of the
highest growth regions of the world (IMF, 2013). It is also inter-
esting that even stock markets began performing impressively.
During the pre-crisis period, African stock markets performed
surprisingly well in terms of both absolute returns and risk-
adjusted returns (Senbet and Otchere, 2010, Allen et al., 2011),
despite the challenges they had faced in terms of low capitaliza-
tion and liquidity.
Moreover, there are currently encouraging forces at play that
enhance the prospects of Africa to integrate into the global finan-
cial economy. For example, there is growing integration of world
capital markets, including those in emerging economies, with
increasing capital mobility. Barriers to international capital flows
have been reduced. In addition, there are rapid advances in infor-
mation technology connecting Africa with the outside world,
allowing outside investors seeking the benefits of international
diversification to access African financial systems in an efficient
manner.
Despite this impressive performance both in terms of finan-
cial sector reforms and economic growth, financial markets
in Africa are considerably less well-developed than markets
elsewhere in the world on virtually all indicators of financial
development (Green, 2013). In fact, the financial sectors of most
African countries remain quite underdeveloped even by the stan-
dards that obtain in low income countries. The development gap
and financial inclusion gap are wide in Africa (Allen et al., 2016).
The development gap pertains to both banking and non-bank sys-
tems. In the non-bank finance area, for instance, based on the
standard measures of trading activity and capitalization, most
African stock markets are quite thin with low levels of liquid-
ity provision. This issue is being increasingly recognized as an
impediment to economic growth, and there are now ongoing
initiatives to build regionally integrated stock markets.
Notwithstanding its less developed status, the financial sector
in Africa weathered the recent crisis remarkably well, especially
when compared to other developing regions. There are several
reasons for this outcome: first, the generally weak integration
with the rest of the global financial sectors meant the potential
for direct contagion was minimal. Second, even in countries such
2 Financial sector development in Africa–an overview / Review of Development Finance 7 (2017) 1–5
as South Africa where the financial sector is well integrated with
the rest of the world, contagion effects were minimal, especially
in the banking sector, largely due to robust regulation of the
banking sectors in Africa (Kose and Prasad, 2010). Third, weak
financial deepening may also have worked to enhance resilience
of the African financial sector through reduced exposure (low
share of private sector credit relative to GDP).
The global financial crisis was a rude awakening to govern-
ments around the world. It revealed severe regulatory gaps and
distorted incentives in the banking sector and the overall finan-
cial system, which lead to a build-up of risk exposures not only
by banks but “shadow” banks as well. The crisis has spurred
renewed efforts to enhance the resilience of the financial sector
by reducing the frequency and severity of future crises through
among other things, the introduction of the Basel III accord.
Moreover, apart from capital standards, there are now standards
for supervision and monitoring of bank liquidity, which typi-
cally arises from a mismatch between short term bank liability
and long term assets. A major feature of the 2008 global crisis
was a sudden dry up of liquidity in the system, which led to the
shutdown of the credit markets in the US and beyond.
Financial sector regulators in Africa have also embraced
some elements of Basel III to strengthen their financial sectors
through beefing-up regulatory capital, improving risk manage-
ment and governance, etc. However, the other challenges faced
by African policy makers include the need to enhance finan-
cial broadening through financial inclusion, as well as financial
deepening (Beck and Maimbo, 2013).
Despite these developments however, a lot remains to be
uncovered regarding the African financial sectors. This spe-
cial issue is informed by several considerations. First, much
of what is known about development finance in breadth and in
detail tends to be based on, to a large extent, the experiences
of the more intensively researched Asian and Latin American
economies, and less on the African experience. Second, the sub-
Saharan African experience itself is diverse, with South Africa
and to some extent Nigeria and Kenya increasing in maturity in
financial market development, while the rest of countries lead
small, relatively underdeveloped and fragmented financial mar-
kets (Green, 2013). This raises the question of how one could
rationalise these varied experiences and whether the “success-
ful” experiences with financial sector development are replicable
in the hitherto less successful economies.
Even among the relatively more successful countries, the
paths followed appear very different. In Kenya, for example,
financial broadening appears to be at the centre of financial sector
development, while the South African case is rooted in financial
deepening. There is thus a need for more country focused studies
to unmask the peculiarities of the different African economies
(see for instance, Allen et al., 2016). Finally, the global finan-
cial crisis, and earlier crises have introduced new uncertainties
for all emerging markets and pre-emerging countries, such as
sub Saharan Africa (SSA). This calls for more research to
inform how SSA can and ought to adapt its financial sectors
to this new environment, and thus enhance its resilience to
shocks, whether they emanate from the domestic or international
environments.
To shed light on these many issues pertaining to developments
in the sub-Saharan African financial sector, and its linkages to
economic performance, the African Economic Research Con-
sortium (AERC) commissioned collaborative research on the
theme: Financial Sector Reform and Development in Africa.
The project is broad in scope, covering issues such as finan-
cial regionalisation and globalisation; financial liberalisation
and how it impacts growth; financial inclusion and finance for
SMEs; financial sector innovations, including mobile money;
banking sector and stock markets developments in sub-Saharan
Africa, and financial sector regulation and competition.
This special issue is based on selected papers from the collab-
orative research. For this review, we categorize the contributions
into four parts, namely access to finance and SME financing,
financial services and inclusion, banking systems and stability,
and markets and developments. In the following section, we
provide an overview of the papers.
1. Part 1: Access to Finance and SME Financing
Financing constraint severely affects developing countries,
particularly African countries and this problem can inhibit firm
growth and exacerbate poverty. Using enterprise-level dataset
from the World Bank’s Enterprise Survey, Babajide Fowowe
investigates the effects of financing constraints on growth of
firms in Africa using both objective and subjective measures of
access to finance. Preliminary analysis shows that African finan-
cial systems are characterized by small banking systems. Banks
in Africa are poor in channeling deposits to the most efficient
uses, signaling low intermediation efficiency. This constraint
leads to situations where banks prefer to invest in government
securities rather than lend to the private sector. In addition,
African banks have low outreach, with banks enjoying high inter-
est rate spreads and targeting short-term finance, to the detriment
of long-term finance for investments.
A key feature of the dataset used in this study is that it pro-
vides a set of subjective measures of access to finance which
reflect firms’ perception of the business environment, as well
as objective measures of the business environment (such as
whether firms have an overdraft facility), which help overcome
the potential shortcomings of subjective measures. The subjec-
tive measures suggest that financial constraint exerts a significant
negative effect on firm growth. Also, Fowowe finds significant
positive relationships between the objective measures of finance
and firm growth; specifically, the objective measures show that
firms that are not credit constrained experience faster growth
than those that are credit constrained, thus prompting the author
to conclude that participation in financial markets promotes firm
growth.
The constraints have led to several outcomes. First, African
firms have limited access to external finance; only about 23
percent of African firms use loans, while about 46 percent of non-
African firms have loans or lines of credit. The author attributes
this state of affair to high interest rates, complex application
procedures, and high collateral requirements, among others.
Second, African firms rely extensively on banks for external
finance, with the sample firms obtaining over 75 percent of
 Financial sector development in Africa–an overview / Review of Development Finance 7 (2017) 1–5
external finance from banks. Third, African firms face high
account fees, high minimum balance, and restrictive documen-
tation requirements. All these factors inhibit firms’ ability to
obtain credit. A policy implication emanating from the results
is that firms that wish to grow must overcome credit constraints
and obtain more external finance. In addition, the development
of credit rating agencies and better risk assessment departments
in banks to ensure effective risk assessment of borrowers can
reduce loan default rate and consequently, bank margins.
One group that is significantly affected by access to finance
or lack of it in Africa is small and medium sized enterprises
(SMEs). In most African countries, SMEs are perceived as
the engine of growth and transformation. However, access to
finance continues to plague this sector. In the second paper,
Peter Quartey, Ebo Turkson, Joshua Abor and Abdul Iddrisu
examine SME access to finance in the West African sub-region
where the problem of access is very acute and has contributed to
the slow growth of SMEs. The authors examine, among others,
whether there are similarities and/or differences in the deter-
minants of SMEs’ access to finance across countries in the
sub-region. They observe that long-term financing in terms of
equity capital is virtually non-existent for the SME sector. In
most countries within the ECOWAS sub-region, the SME sector
faces serious constraints in accessing formal finance. Factors
such as lack of collateral, difficulties in providing creditwor-
thiness, small cash flows, inadequate credit history, high risk
premiums, underdeveloped bank-borrower relationship and high
transaction costs account for this state of affair. Various SME
finance programmes adopted by governments, such as interest
rate subsidies, directed lending, and guaranteed funds have not
succeeded in alleviating the financing problems facing the SME
sector partly because of lack of efficiency and transparency in
the operation of such programs.
Using subjective measures derived from the survey responses
of the firms in the WBES database and objective measures of
a firms’ access to finance which they derived from the share
of internal and external financial resources of working capi-
tal, the authors conduct the analyses first at the sub-regional
level by examining the determinants of access to finance. The
sub-regional level analysis has the tendency to obscure some
important differences in terms of the influence of the various
explanatory variables on access to finance. Consequently, to
unmask important differences across countries, the authors also
conduct country level analysis that delineates the differential
effects.
At the sub-regional level, the authors find that firm size,
ownership, strength of legal rights, depth of credit information,
a firm’s export orientation and the experience of the top man-
ager strongly influence access to finance. At the country level,
they find that the determinants of access to finance varies across
countries. One striking result is that in Mali, where govern-
ment support for SMEs is directed more towards women-owned
businesses to meet the Government’s Millennium Development
Goals (MDGs), the gender of top manager significantly deter-
mines a firm’s access to finance. Also, women in Mali mostly
engage in small businesses that do not require huge investments,
and this provide little incentive for them to seek financing from
3
banks and other financial institution. The Malian case is unique
and does seem to contradict the conventional notion that women
disproportionately face barriers to finance compared to their
male counterparts. It nonetheless shows how government policy
can be used to address access issues if the political will to do so
is strong.
2. Part II: Financial Services and Inclusion
There is widespread recognition in the developing world
that financial inclusion can reduce poverty, enhance growth,
and promote sustainable development. Development agencies
such as the World Bank realize that inclusive financial sys-
tems not only enable poor people to save and borrow, and thus
allow them to invest in entrepreneurial ventures, but they also
help insure beneficiaries of inclusive programs against socio-
economic vulnerabilities. Technological advances, especially
the use of mobile phones, have facilitated the provision of finan-
cial services to the poor in a relatively cheap and reliable manner.
African countries have experienced a boom in the use of mobile
phones, which have helped solve both problems of distance
or access and transaction costs that have hindered traditional
financial services providers in the past from extending services
to the hitherto unbanked. In the third paper, Alfred Shem,
Maureen Odongo and Maureen Were examine whether the
pervasive use of mobile telephony to provide financial services
has enhanced savings mobilization in Africa. In the sub-Saharan
African region, the East African countries have recorded signifi-
cant improvement in the use of mobile money, and this motivates
the authors to focus on Kenya, Uganda, Malawi and Zambia.
However, Kenya has been the leader in the use of mobile tele-
phone financial services. Therefore, the authors conduct a more
in-depth empirical analysis on Kenya.
Using both descriptive statistics and regression analyses, the
authors test the hypothesis that mobile phone money usage
encourages savings. They find that mobile financial services pos-
itively impact savings and that those who utilize or have access
to mobile financial services are far more likely to save than those
who do not. Higher levels of education or financial literacy and
income have positive effect on savings, but family size has neg-
ative effects on savings, as high dependency ratio constrains the
ability to save. While women are more likely to save than men,
the latter save more money than women. A policy implication
that emanates from the results is that expanding and deepening
the scope of mobile financial services is an important avenue
for promoting and mobilizing savings particularly for the poor
and low income earners who have limited access to the formal
financial system.
The paper by Andreas Freytag and Susanne Fricke assesses
the overall economic effects stemming from the sectoral link-
ages of the financial services sector in Nigeria and Kenya, -
countries that have relatively developed financial sector in sub-
Saharan Africa.1 Inter-sectoral linkages, comprising backward
1 South Africa is excluded from the study as there are similar studies on this
country already.
4 Financial sector development in Africa–an overview / Review of Development Finance 7 (2017) 1–5
and forward linkages, reflect the interconnectedness between the
sectors of an economy, with mutual interdependencies between
sectors influencing the extent to which growth in one sector
contributes to growth of other sectors as well as the overall
growth. The financial sector is crucial for a country’s econ-
omy and business environment, as it provides opportunities for
employment and income generation, savings and investment,
wealth accumulation and loan provision; hence its development
can have positive spillovers effects on other sectors. The effect
of inter-sectoral connectedness of financial services in emerging
countries, especially in Africa has not been analyzed in detail.
Using input-output analysis comprising assessments of back-
ward and forward linkages of the financial sector to the other
sectors of the economy and the assessment of overall eco-
nomic (multiplier) effects emanating from the financial sector,
the authors find evidence of sectoral interconnectedness of the
financial services sector in the Nigerian and Kenyan economies.
The Nigerian economy shows relatively low direct backward
and forward linkages for the financial services sector, and the
values for total backward and total forward linkages rank high-
est during the study period (2007, 2009 and 2011). The high
total backward linkages indicate that the financial services sec-
tor creates additional demand for the output of upstream sectors,
leading to increased upstream investment, capacity utilization
and upstream technological upgrading. For Kenya, direct and
total backward linkages as well as direct and total forward link-
ages rank relatively low. As the authors argue, the relatively low
values do not allow for a distinct assignment of growth-inducing
or growth-enabling functions of the financial services sector in
the country. The results show that the financial sector plays a
more significant role in the Nigerian economy than the Kenyan
economy. However, controlling for the role of technology or
the communication sector within both economies results in low
linkages of the financial sector in both countries.
3. Part III: Banking Systems and Stability
Jacob Oduor, Kethi Ngoka, and Maureen Odongo investi-
gate the impact of regulatory capital beef-up on banking sector
stability and competition. Their study is motivated by the flurry
of actions by financial sector regulatory authorities, particularly
central banks, in the aftermath of the global financial crises.
Many African countries have increased, or are in the process of
increasing regulatory capital in line with Basel III pronounce-
ments with the view to strengthening the resilience of local banks
to shocks. The questions the authors address are: (1) whether
increasing regulatory capital increases stability of the banking
system, and (2) how increasing regulatory capital affects bank-
ing sector competition given that raising the capital adequacy
requirements tends to increase concentration of the banking
sector.
The authors employ panel study approach to investigate the
impacts of capital requirements on financial sector stability
and on competition in the financial sector. Using data on 162
commercial banks in 37 African countries over the period 2000-
2011, and measuring financial sector stability by nonperforming
loans and competition by the Lerner Index, the authors find no
significant impact of regulatory capital on competition in the
banking sector. However, they find evidence of positive impact
of regulatory capital on competition among foreign banks. The
authors surmise that this could be due to the fact that foreign
banks may obtain additional capital at concessional rates from
their parent companies and thus do not bear the full brunt of
the costs arising from higher regulatory capital requirements,
unlike domestic banks that have to source the additional capital
on the open market. The higher costs faced by domestic banks
are passed on to consumers, resulting in reduced competitiveness
of domestic banks.
Regarding the impact of increasing regulatory capital on
financial sector stability, the authors find that raising the reg-
ulatory capital requirement increases instability in the African
banking sector. However, the big banks do not experience insta-
bility. The authors assert that increasing regulatory capital ratios
could be encouraging banks to hold more risky assets by under-
stating their risks. They do so through the use of complex
in-house risk assessment models. Consequently, banks in effect
hold less regulatory capital than they are supposed to have
given their risk profiles and this outcome explains the insta-
bility. The authors conclude that raising regulatory capital may
not be sufficient to mitigate financial sector instability in the
African banking sector and that additional measures may be
needed. They also conclude that the nature of ownership of
banks and bank size matter for the impact of regulatory capital
on competition in the banking sector.
Relatedly, Eftychia Nikolaidou and Sofoklis Vogiazas also
explore the issue of financial sector stability, but from a slightly
different vantage point. The authors examine the credit risk
determinants in five sub-Saharan African (SSA) countries and
attempt to relate the situation in the five African countries to
the experiences of the Central East and South East European
countries. The paper is motivated by the dearth of studies on
credit risk determinants in sub-Saharan African countries. The
authors argue that there aren’t many studies that address this
issue, and given the importance of banking sector stability for
sound economic performance, and the impact of credit risk on
stability of the banking sector, it is imperative that more light is
shed on the drivers of credit risk in SSA. The five study countries
are South Africa, Namibia, Kenya, Zambia and Uganda. Data
considerations and the need to sample across countries at differ-
ent stages of development inform the choice of countries.
The authors use the Autoregressive Distributed Lag (ARDL)
methodology, and a ‘case study’ approach for each country.
They find that in the long run, non-performing loans (NPLs) are
primarily driven by macroeconomic factors, especially money
supply. This is explained by the fact that the banking sector in
the five SSA countries are generally stable and well capitalized,
with low loan-to-deposit ratios. Thus, the risks tend to emanate
from outside the banking sector. The results suggest that easing
(expansionary) monetary policy is associated with lower NPLs.
They also find that, apart from monetary policy variables, NPLs
are driven by different factors in different countries. In other
words, country-specific factors are important drivers of NPLs in
the five sub-Saharan African countries. Parallels and lessons are
drawn from CESEE countries’ experiences.
 Financial sector development in Africa–an overview / Review of Development Finance 7 (2017) 1–5
4. Part IV: Markets and Development
Extant literature shows that African stock markets are small
and are characterized by poor liquidity, high concentration
and insufficiently developed market infrastructure. The inte-
gration of national stock exchanges has been proposed as a
solution to some of these impediments. Establishing regional
stock exchanges also offers other benefits including harnessing
much needed capital to the African countries. Despite these ben-
efits, progress towards stock market integration for African stock
exchanges has been slow. Sunil Bundooanalyses the extent
of stock market integration in the Southern African Develop-
ment Community (SADC) region. The SADC members have
established national stock exchanges in Botswana, Malawi,
Mauritius, Mozambique, Namibia, South Africa, Swaziland,
Tanzania, Zambia, and Zimbabwe. The author assesses the
degree of beta and sigma convergence and identifies the exist-
ence of long-run equilibrium relationships in the stock market
returns.
A Committee of SADC Stock Exchanges has been set up to
promote a transparent regulatory environment that aims at pro-
tecting market participants, attracting investors, improving the
exchanges’ operational capacity and technical underpinnings,
promoting cooperation, harmonization of trading, clearance, and
settlement procedures among the exchanges, and providing a
forum for information exchange and discussion of development
of the region’s stock markets. Using price-based approach to
measure stock market integration, the author does not find any
evidence of cointegration relationship of the SADC markets
when using the US market as benchmark, except during the
financial crisis when the markets were cointegrated. The SADC
stock markets, however, offer good diversification benefits to
foreign investors. The stock exchanges in the region are there-
fore urged to work towards greater integration so that they can
attract more sustained portfolio flows.
In the last paper, Ousmanuo Njikam investigates the role of
policy complementarities in the financial liberalization-growth
nexus. The study is motivated by the fact that while nearly all
African countries have liberalized their financial sectors, the
growth impact of financial liberalization in the region remains
weak, at best. This state of affairs seems to contradict the evi-
dence in the literature (e.g., Stiglitz, 1998) which touts financial
liberalization as a key driver of economic growth. The ques-
tion then is: why is the evidence in Africa not consistent with
what has been documented elsewhere? The author hypothesizes
that complementary reforms, or their absence, could be the rea-
son for the insignificance of financial liberalization in impacting
growth.
Based in this conjecture, the author examines the relationship
between economic growth and financial liberalization across
sub-Saharan African countries, with the view to ascertaining
5
how policy complementarities affect this relationship. Using a
sample of 45 sub-Saharan African countries, the author finds
that in the absence of policy complementarities, per capita GDP
growth in the post-liberalization era is not statistically different
from that of the pre- liberalization period. However, finan-
cial liberalization positively affects growth if accompanied by
improvements in schooling, governance, macroeconomic sta-
bility, etc. Inflation is found to reduce the impact of financial
liberalization on economic growth. An implication of the study
is that sub-Saharan African countries could potentially realize
substantial GDP per capita growth if greater attention is paid
to policy reform complementarities (involving human capital,
macroeconomic stability, governance, etc.). In essence, these
areas can be considered as the binding constraints to growth in
sub-Saharan Africa.
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Isaac Otchere a
Lemma Senbet b
Witness Simbanegavi b
a Sprott School of Business, Carleton University
b African Economic Research Consortium (AERC)